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How To Profit From The End Of Momentum

#-ad_banner-#Watching the stock market closely over the last
week brought Bob Dylan's words to mind. The Dow Jones Industrial
Average plunged over 600 points in six trading sessions, and the
high-flying Nasdaq Composite Index sustained its largest drop in
over two years.

What's more, five of the 14 IPOs slated for the past two weeks
postponed their launches due to the sell-off. The majority of
this selling was by hedge funds slashing their risk exposure,
according to The Wall Street Journal, sending shivers of fear
into even the most hardened of stock market players.

This selling is different than what we witnessed in January.
The January selling was triggered by the fear of a change in
Federal Reserve policy and simple profit-taking. Last year's bull
market prompted many investors to simply wait until January to
cash in so they could delay paying taxes on their fat gains for
another year.

In contrast, the current selling appears to be a shift from
high-flying growth stocks to defensive stocks. I think this
selling is signaling that the smart money is starting to position
itself for a flat to down stock market in 2014.

Biotechs and other high-momentum stocks like many
internet/high tech names have been slammed lower -- but stodgy
stocks like
McDonald's (NYSE:MCD)
,
IBM (NYSE:IBM)
and
Procter & Gamble (NYSE:PG)
have been inching higher.

In addition, hedge funds have reduced their overall long
exposure to equities from 58% to 46%, according to Credit Suisse.
In the United States, net long positions are at their lowest
levels since August 2012.

Most telling is that the CBOE Volatility Index (VIX), also
known as the fear gauge, had soared 30% since April 2, to just
over 17, before drifting back down.

Believe it or not, this is great news.

Savvy investors welcome this shift for two primary reasons.
First, it may allow stocks to be purchased at a sharp discount
from their recent heady highs. Second, investors can profit from
the fear by shorting stocks.

One of the most amazing things about the stock market is it
really doesn't matter which way it moves -- active investors can
still make money. While many passive investors are trapped in
long-only mutual funds and similar products, active investors
retain the flexibility to capture profits in both bullish and
bearish markets.

I expect the markets to continue downward, closing the year
flat or lower. This will be my bias until the market proves it
wrong -- namely, until the major indices take out the all-time
highs.

I'm not yet expecting a sharp plunge or crash from here --
just a slow drift downward into the fall months. This certainly
doesn't mean stock will not rally during the slow grind downward.
They certainly may -- but the edge will be shorting any sharp
rallies.

Obviously, in these conditions, searching for shorting
opportunities in the previous high-flying momentum stocks makes
sense.

My favorite short play in these conditions is to short the
iShares MSCI USA Momentum Factor ETF (NYSE:
MTUM
)
. Built on mid- and large-cap momentum stocks, MTUM is down
almost 4% for the year. Containing 125 stocks that exhibit higher
momentum characteristics than the overall market, this ETF is
composed primarily of the same stocks that hedge funds are in the
process of dumping.

Source: BlackRock

Launched last April, the ETF is relatively new, but it has
grown to nearly $195 million in net assets, representing a
portfolio with a total market cap of $3.8 trillion. Due to its
composition, I think MTUM will continue to be pressured downward
even if the overall market regains its footing.

Risks to Consider:
Shorting is dangerous since it goes against the inherent
upward drift of stocks. It can be very lucrative since markets
often sell off faster than they climb higher. While I expect this
shift away from the momentum stocks to continue, it's important
to note that the fundamentals supporting the overall stock market
remain intact. Always use stop-loss orders and diversify when
investing. This is particularly critical if you have short
positions.

Action to Take -->
Shorting the MTUM ETF within the channel makes good investing
sense right now. Remember to expect updrafts in price on the way
to the targeted $51. I will remain confident in the position
until the stops at $61.50 are hit.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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